Cal-Maine Foods: Cheaper by the Dozen

Moving off media & entertainment for now; today I want to talk about eggs.

Cal-Maine Foods (CALM-Nasdaq) is a vertically integrated US shell-egg and egg products producer. It is the largest in the US within a very fragmented market. I see a mean-reversion opportunity with an investment horizon of 1 to 2 years (full disclosure, over this year, it may trade sideways). I believe after the 1–2 year period, the stock can return to US$50–55 per share, representing a 35 to 45% upside on the current share price. As well, I expect the stock to continue doing well in the future and can be a long-term hold until the next supply/demand shock causing the cycle to repeat.

Over the last 15–20 years, Cal-Maine has attained its market-leading status through a combination of organic growth and strategic acquisitions (of capacity), and continues to be a consolidator. Despite being the largest, Cal-Maine only has a market share of 23% of US shell eggs. Moreover, the top 10 producers only command 50% of the market share without any single player in a position to dictate supply/pricing.

The company is highly levered to egg prices but it has ~80% of costs being variable. The egg market is tightly balanced with very price-elastic supply/demand. An upset to this balance leads to fluctuations in egg prices. And that’s just what happened in mid-2015.

The US was hit by an onset of Avian Influenza. This caused a steep drop in hen population due to sickness, leading to egg under-supply. Under-supply drove up the prices of eggs. Consequently, given the fragmented market, market participants saw an opportunity to capture extra profits and/or replace lost flock, leading to a scramble (ha) to hatch hens. As per typical prisoner’s dilemma, this caused the worst outcome for all — oversupply, leading to a subsequent sharp drop in egg prices (from over US$2 per dozen for non-specialty eggs to ~US$0.60 per dozen at the trough).

Figure: Total US Table-Egg Producing Flock (000s)

Source: USDA
Before we go any further, I have to first illustrate the short and miserable but highly productive life of a typical egg-laying hen. After the hen is hatched, from 0 to 18 weeks, it is a non-producing chick — called a pullet — where it is reared and conditioned to maximize output throughout its life. Between 18–30 weeks, the hen ramps and hits its peak productivity (>90%). From there, at 30 weeks to 60/70 weeks, productivity declines until it drops to 50%, when it is no longer economical to keep the flock producing. This is when the entire flock is rested and molted — between 70 to 80 weeks. Once complete, the hens, now, slightly less productive (~80%) but generally producing larger eggs, will see through this short cycle for another 30 weeks (to week 100/110). Given lower productivity, the second laying cycle can be optional. After this, the hens are typically sold to be slaughtered. This is meant to illustrate the typical life, and can be longer or shorter.

Figure: Egg Laying Cycle

Source: http://ag.ansc.purdue.edu/poultry/publication/commegg/

Avian Influenza hit in mid-2015. This was followed by farmers producing more hatch-type eggs while hatching more hens. Hatch-type egg supply peaked in May 2016.

Figure: US Total Hatch-type Eggs Produced

Source: USDA

Working through our timeline, it takes around 35 to 40 weeks to hit peak production (including the hatching period). This places the peak hen population at around December/January 2017. Productivity should fall from this point on and we should begin to see productivity decline until they hit 75 to 85 weeks when the hens begin their molt. This places the timeline at around October/November 2017. Assuming the flocks are kept for a second laying cycle, the current peak flock should die out at around June/July 2018. Over this period, the flock would also be much less productive.

Figure: Timeline of Peak Flock

Source: Author

This corroborates with USDA data I have collected. Refer to Figure: Total US Table-Egg Producing Flock which shows table egg laying flock peaking in December/January and not rising since. However, given we are currently in the time period of peak productivity, the industry is producing the most table eggs ever.

Figure: US Table Egg Productivity

Source: USDA

Data points to a correction already beginning to take place. I observe hatch-type flock and hatch-type eggs now far below 2015 levels. Moreover, I observe pullet placement (placing newly hatched hens in pens) are also on a clear downtrend after peaking in Jun 2015.

Figure: US Hatch-Type Flock Produced

Source: USDA

Figure: US Pullet Placement (LTM)

Source: USDA

The company faced a similar supply/demand shock in late 2003/early 2004. A fad diet led to an increase egg demand and egg prices. Farmers saw an opportunity and expanded its flock to capture higher prices. When the fad diet ended in mid-2004, there was once again an oversupply, leading to a plummet in egg prices. Working backwards in our timeline, it took approximately 1.5 years to go from peak to trough. Then around another one (1) to 1.5 years for supply to decline enough to meet a slowly rising demand eventually balancing the egg market once more to reach normalised egg pricing.

In our current cycle, prices peaked at around May 2015. 1.5 years brings us to year-end 2016, the trough. From there it will likely take another one to 1.5 years for demand/supply to balance. This is around year-end 2017 to mid-2018. This corroborates with our analysis above. (Note, company fiscal year ends at the end of May)

Figure: Price Progression Since Last Demand/Supply Shock

Source: Company Financials, Author’s Estimates

Figure: Gross Margins Since Lasts Demand/Supply Shock

Source: Company Financials, Author’s Estimates

Figure: EBITDA Margins Since Lasts Demand/Supply Shock

Source: Company Financials, Author’s Estimates

So if you are willing “stay calm and invest on” for a period of about a year, this seems like a decent place to park your money. There are other factors which lead me to think CALM will emerge even stronger after price normalization. So even after prices normalize, this will be a decent long-and-hold candidate… Up until the next time egg prices spike.

Again, if you want to see financials, feel to free to message.

Disclosure: I am long CALM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.